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Exam 3: Tax Planning Strategies and Related Limitations

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Question 51

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Susan Brown has decided that she would like to go back to school after her kids leave home in five years. To save for her education, Susan would like to invest $25,000 in an investment that provides a high return. If her marginal tax rate is 35 percent, what is Susan's after-tax rate of return for the following investment options? Qualified dividends are taxed at 15 percent. (1)Corporate bond issued at face value with 10 percent stated interest rate payable annually. (2)Dividend-paying stock with an annual qualifying dividend equal to 10 percent of her investment. (3)Growth stock with an annual growth rate of 8 percent and no dividends paid. (Round your interim calculations to the nearest whole number.)

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(1)Corporate bond
0.10 × (1 − 0.35)= 6.5...

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Question 52

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Which of the following tax planning strategies is based on the present value of money?

A) Timing
B) Tax avoidance
C) Income shifting
D) Conversion
E) None of the choices are correct.

F) A) and E)
G) C) and D)

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Question 53

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Which of the following is an example of the timing strategy?

Jared, a tax novice, has recently learned of several foreign tax havens (i.e., countries with low tax rates). He is considering locating his manufacturing operations in one of these countries solely based on their low tax rates. What types of taxes is Jared ignoring? Explain how these other taxes may affect the viability of Jared's choice to locate in a foreign tax haven.

If Julius has a 22 percent tax rate and a 8 percent after-tax rate of return, $55,000 of income in three years will cost him how much tax in today's dollars? Use Exhibit 3.1. (Round discount factor(s) to three decimal places.)

Investors must consider complicit taxes as well as explicit taxes in order to make correct investment choices.

Assume that Shavonne's marginal tax rate is 37 percent and her tax rate on dividends is 15 percent. If a corporate bond pays 10.20 percent interest, what dividend yield would a dividend-paying stock (with no growth potential) have to offer for Shavonne to be indifferent between the two investments from a cash-flow perspective?

Which of the following decreases the benefits of accelerating deductions?

The timing strategy is particularly effective for cash-basis taxpayers.

If tax rates are increasing:

Investing in municipal bonds to avoid paying tax on interest earned and to earn a higher after-tax yield is an example of:

Joe Harry, a cash-basis taxpayer, owes $20,000 in tax-deductible accounting fees for his business. Assume that it is December 28^th and that Joe Harry can avoid any finance charges if he pays the accounting fees by January 10^th. Joe Harry's tax rate this year is 24 percent. His tax rate next year will be 32 percent. His after-tax rate of return is 8 percent. When should Joe Harry pay the $20,000 fees and why? Use Exhibit 3.1. (Round discount factor(s)to three decimal places.)

The conversion strategy capitalizes on the fact that tax rates vary across different activities.

If Lucy earns a 6 percent after-tax rate of return, $8,000 received in four years is worth how much today? Use Exhibit 3.1. (Round discount factor(s) to three decimal places.)

If Thomas has a 37 percent tax rate and a 6 percent after-tax rate of return, $50,000 of income in five years will cost him how much tax in today's dollars? Use Exhibit 3.1. (Round discount factor(s) to three decimal places.)

There are two basic timing-related tax rate strategies. What are they? What is the intent of each strategy? In which situations do the tax rate and timing strategies provide conflicting recommendations? What information do you need to determine the appropriate action?

Assume that Marsha is indifferent between investing in a city of Destin bond that pays 4.05 percent interest and a corporate bond that pays 6.05 percent interest. What is Marsha's marginal tax rate? (Do not round intermediate computations.)

The constructive receipt doctrine is more of an issue for cash-basis taxpayers.

Assuming an after-tax rate of return of 10 percent, John should prefer to pay an expense of $85 today instead of an expense of $100 in one year. Use Exhibit 3.1.

Which of the following increases the benefits of income deferral?